Crude oil prices hit its lowest since December 2021 early this month. The West Texas Intermediate (WTI) crude futures for October contract was trading at US$65.75 per barrel, whilst the Brent crude oil for November contract  was US$69.19 per barrel. Meaning since the beginning of the year, both WTI and Brent had declined 8.2% and 10.2% respectively.

 

Basically, there were two reasons for the sell-off. First, OPEC had cut its demand outlook in August due to weakening economy in China, the world’s largest crude importer. Second, China’s skyrocketing sales of electric vehicles translate to softening demand for fuel. OPEC sees demand growth of only 1.7 million barrels per day (bpd) next year, about 40,000 bpd lower than originally anticipated.

 

However, the crude oil prices rebound during the third week of September 2024 and even hit a two-week high amid a large interest rate slash (50 basis points) by the Federal Reserve and plunging global stockpiles. The strategic move of OPEC+ members to pause its planned production hike of 180,000 barrels per day in October and November also helped push up the commodity prices.

Disruptions in crude oil production in the Gulf of Mexico and a fire broke out at the second-largest oil refinery in Greece have also stabilized the oil prices. Still, at US$67.50 (WTI) and US$71.20 (Brent) today, the crude is ridiculously low. It should have easily hit above US$100 per barrel as a result of two major wars – the Russia-Ukraine War and the Israel-Hamas War (which has escalated to Lebanon).

 

So, exactly why are the crude oil prices so cheap? They are cheap because OPEC+ cheats. Since the beginning of the year, the OPEC+ countries that are subject to output caps have pumped together more than 600,000 barrels a day above their self-imposed limits. The overproduction (or rather cheating) last month alone reached nearly 850,000 barrels a day – equivalent to Venezuela’s output.

 

The “Cheating Game” is a key reason why oil prices have fallen so much over the last two months – down 20% over the last year to US$75 a barrel. And also why many in the energy market are skeptical that the cartel can push prices higher in 2025. The group of OPEC members has a long history of cheating on quotas anyway. And when they fail to keep oil prices high and stable, they like to blame everyone else.

The biggest problem with Saudi-led Organization of Petroleum Exporting Countries problem is one of trust. If most OPEC+ members (an alliance between the OPEC and non-OPEC members such as Russia) ignore what’s expected from them, and repeatedly cheat, the temptation to cheat only grows. The best part was the multiple promises by OPEC+ to stop cheating, only to cheat again.

 

The cartel’s agreements usually spell out exactly how many barrels a day each member must cut. But ensuring that everyone complies by these quotas is only based on a dubious and fragile honour system. There was no effective mechanism for punishing members that stray from their pledges. Therefore, striking a deal and enforcing it is two totally different things.

 

It’s a public knowledge that within OPEC+, everyone distrusts each other as OPEC members always game production figures in efforts to protect their own market share, so much so the production data are often in dispute. Because OPEC is like one big family, cheaters often get a slap on the wrist. Over time, the oil market assumes that cheating becomes a standard practice.

The more OPEC+ says it’s going to end cheating but doesn’t, the more the market laughs at it. It became so bad OPEC has to publish two sets of numbers – production estimates it gathers from independent sources, and figures reported directly by the members. For example, Petro-Logistics SA in Geneva collects intelligence through a network of sources stationed around the world.

 

Still, it doesn’t solve the cheating problem. When the price of oil goes up a bit, everybody will be tempted to cheat. In 1985, Saudi Arabia officials said they grew so tired of fellow members ignoring their agreed-upon quotas that the kingdom abruptly raised production in retaliation, sending crude prices into a tailspin. Some disputes and disagreements turned violent.

 

In July 1990, when crude oil prices dropped from US$18 to US$12 per barrel, Iraqi President Saddam Hussein threatened an attack if Kuwait didn’t comply with its production limit. The national revenue of Iraq depended mostly on oil, and Iraq considered it important to maintain high oil prices to ensure adequate revenue sources for the repayment of its debts and for its recovery from the Iran-Iraq war. 

Iraq also blamed the United Arab Emirates for the price drop as a result of overproduction of crude oil, but fortunately to the UAE, Saddam cannot invade it without going through Saudi Arabia. Kuwait was also being accused of constructing military and oil facilities on Iraqi territory while Iraq was concentrating on the Iran-Iraq war. On that pretext, Saddam demanded that Kuwait write off its debt obligations.

 

Kuwait eventually slashed production, but Mr. Hussein invaded anyway. On August 8, 1990 Iraq announced the unification of the two countries, which in reality was the annexation of Kuwait. The Iraqi forces then moved south, mobilizing 100,000 troops toward the border of Saudi Arabia, leading to the possibility of Iraq invading Saudi. A few months later the Gulf War broke out.

 

Realizing the challenge, Saudi Energy Minister Prince Abdulaziz bin Salman has made increasing compliance with the output quotas a personal mission, including creating the so-called “compensation” mechanism in 2020. Under that new tool to push members to atone for cheating on their supply quotas, the cheaters must offset their overproduction over time.

On paper, the mechanism sounds sexy. The scheme was supposed to ensure that members unable to cut production in line with the production quota set could compensate by reducing production gradually over the following months. However, old habits die hard – the cheaters not only continue to cheat on their original quotas but also on the compensation quotas.

 

OPEC Secretary-General Haitham Al-Ghais recently traveled to Iraq and Kazakhstan, two of the top cheaters, to discuss the “timely implementation of production adjustments, including the compensation plans.” Iraq overproduced 1.44 million barrels per day (bpd) from January to July, whilst Kazakhstan overproduced 699,000 bpd. OPEC called the trips “successful.”

 

According to the updated compensation plans for their overproduced oil volumes in the first seven months of 2024, Iraq and Kazakhstan are set to begin compensating for their overproduced volumes beginning August 2024 till September 2025. However, as expected, the latest production estimates show they haven’t even started yet with the programme.

Internal OPEC+ documents show that members had a poor track record of compensating for overproduction in previous rounds of cuts in 2021. The OPEC data from 2021 show that Iraq’s backlog of overdue curbs barely changed that year. In fact, since its introduction in mid-2020, the OPEC+ mechanism of compensation for overproduction has rarely been honoured.

 

Worse, the deadline for these countries to complete their penance was repeatedly extended. By October 2021, more than a year after the compensation mechanism was launched, the backlog of additional curbs owed by Iraq and Kazakhstan had swelled rather than diminished. They continue to cheat knowing very well that they could get away with it.

 

But Iraq and Kazakhstan were not the only cheaters. The UAE too is a serial cheater. Abu Dhabi claims it pumps just 2.9 million barrels a day, exactly as it should. OPEC, which tracks member production by following several external data providers, puts UAE output at about 2.9 million barrels a day. The International Energy Agency (IEA), however, puts Emirati oil production at 3.3 million barrels a day.

Why is OPEC closing both eyes over Abu Dhabi’s cheating? Politics. The cartel is striking a balance between allowing the UAE to profit from the billions of dollars it has spent in new production facilities and keeping the global oil market stable. Saudi Arabia, the UAE, Bahrain, Egypt, Kuwait, Jordan, and Morocco are considered close allies, who have formed an alliance to counter Iran and the Muslim Brotherhood in the region.

 

And we have not even talked about Russia, another repeat cheater. The Ukraine War makes it impossible for Moscow to refrain from cheating. Essentially, every member of OPEC+ cheats. If they have a poor track record of compensating for overproduction in previous rounds of cuts in 2021, chances are cheating will continue in 2025.

 

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September 26th, 2024 by financetwitter

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